While working with independent contractors is an excellent business practice, employers should know that the IRS and Department of Labor (DOL) will check if these contingent workers meet specific criteria that distinguish them from employees. If you’re paying independent contractors who should be classified as employees, you’re running the risk of having to pay back taxes and facing other stiff and hefty penalties.
What You Should Know About Employee Misclassification
What Exactly Is It?
Employee misclassification involves labeling workers as independent contractors instead of employees. Furthermore, it’s a legal decision made by government regulators that individual workers weren’t correctly categorized under the law. Moreover, misclassification usually happens when an independent contractor or freelancer is engaged under a “contract of service” work that is considered to be that of an employee.
Why Are Authorities Concerned About It?
Incorrect Deduction of Expense
Contingent workers are typically entitled to deduct various expenses from their gross income. These expenses, such as office equipment, deductions for transport, pension contributions, and private health insurance, aren’t permissible deductions for employees.
Misclassifying an employee as an independent contractor causes these workers to claim such expenses illegitimately. As a result, tax authorities lose income tax revenue when these workers file their individual income taxes.
No Tax Withholding
Although a business can actually pay a contingent worker and an employee for the same work, which is a red flag in itself, significant legal differences exist between the two. While companies don’t withhold income tax, Social Security, and Medicare taxes from amounts paid to an independent contractor, they withhold taxes from an employees’ wages.
In addition, companies don’t pay the employer’s portion of Social Security, Medicare, and unemployment taxes from amounts paid to an independent contractor like they do when they pay employees’ wages.
Consequently, the absence of tax withholding and employer taxes due to employee misclassification deprives the state and federal governments of properly due tax revenue necessary for paying public services and benefits, including unemployment insurance.
Lack of Employee Protections
Independent contractors aren’t protected by the Fair Labor Standards Act and most state and federal employment laws. For this reason, improperly classifying workers as independent contractors deprives them of the legal protections afforded to employees. These employee protections include wage and hour laws, workers’ compensation coverage if they’re injured on the job, health insurance and other employee benefits, and unemployment benefits should they lose their job.
Deprivation of Benefits
Federal mandatory employee benefits include Social Security and Medicare, workers’ compensation insurance, unemployment insurance, and Family and Medical Leave Act (FMLA) protections. Moreover, the law requires employers and employees to contribute to these funds. Misclassification deprives workers of these benefits while increasing the burden on the state and federal governments as they provide essential services to misclassified workers.
Social Security and Medicare are designed to assist older Americans and distribute benefits to disabled individuals and their families. While Social Security provides financial support, Medicare is a health insurance program that helps cover hospital stays, doctor visits, and other medical treatments.
Workers’ compensation insurance helps individuals who cannot work due to a workplace illness or injury by providing them with financial support. On the other hand, unemployment insurance replaces a portion of wages for people during unemployment.
The FMLA entitles employees of covered employers to take unpaid and job-protected leave for specified family and medical reasons. Eligible individuals are entitled to a continuation of a group health insurance coverage under the same terms and conditions as if they hadn’t taken leave.
Are You Paying Independent Contractors Who Should Be Classified as Employees?
At ClearPath, we provide expert, personalized service to help you classify with confidence and get back to focusing on your business goals. Contact us today to make an appointment.